Moody's warns on rising bank home loan risks

Ratings agency Moody's is warning that Australian banks are increasing the proportion of risky home loans they are making.

Figures from the banking regulator, the Australian Prudential Regulation Authority have confirmed a strong rise in investor loans, interest-only loans and non-conforming mortgages where borrowers do not meet the usual eligibility standards - all of which are considered to put banks at a higher risk of losses.

Moody's senior credit officer and vice-president Ilya Serov says the regulator had warned banks about giving out too many high loan-to-value (LVR) ratio loans, which also present a higher risk of losses.

However, while loans where the bank is lending more than 90 per cent of the home's value have decreased marginally - from 14 per cent of new loans last year to 12.5 per cent as of June 2014 - Mr Serov says banks have increased sales of other risky loans instead.

"Despite the regulators efforts to reign in some of the higher risk lending in Australia, in fact what's happening in the market is that some of that more high-risk type lending is still going on," he said.

The June quarter APRA figures released last week show investor home loans have risen to 37.9 per cent of all new lending, compared with an average of 32.6 per cent over the prior six years.

Mr Serov says loans to investors have a higher chance of default, as the owner is not living in the property, and also tend to have higher LVRs.

"Typically these are more leveraged loans, so the borrowers take up more borrowing for the same property," he explained.

Interest-only loan default warning

Perhaps more worrying to Moody's is the increase in loans with an interest-only period - more typically taken out by investors than owner-occupiers.

APRA's figures show 43.2 per cent of loans taken out in the June quarter were interest-only, and a record 35.7 per cent of all outstanding loans fall into this category.

Mr Serov says this poses a high risk to borrowers and banks several years hence.

"Typically what you see is that the interest-only period is only three or five years and at the end of that it reverts to a principal and interest payment which is of course much higher," he said.

"The dollar amount of repayment goes up and some borrowers may go into delinquency."

Mr Serov warns that this is likely to be compounded by an increase in interest rates between now and the end of the interest-only period.

"We expect interest rates to rise over the next 12 to 18 months and that means for the loans that we have identified, at the end of that period, there is an increased likelihood of a payment shock," he added.

Moody's also points to a record proportion of loans approved outside normal lending standards, meaning the borrowers have not passed the typical tests about meeting higher repayments when interest rates rise.

These loans still only make up 3.7 per cent of the mortgage market, but this is the highest level recorded over the past six years.

Banks still sound, report a wake-up call: Moody's

Mr Serov says Moody's still sees the Australian banking system as resilient, and the report does not mean any downgrades are imminent.

"We generally see the Australian banking industry as being quite well capitalised, there are certainly some issues around the consistency of the application of capital rules across different types of institutions, particularly from a competition point of view, and that's something the [Financial System] Inquiry is looking into," he said.

However, Mr Serov says the report is a warning to the banking sector that continuing to issue a high and rising proportion of riskier loans would ultimately result in reduced creditworthiness.

In a separate report out today, Moody's has also warned that stronger home lending and weaker deposit growth means Australian banks will have to raise more of their funding from overseas.

"Given that Australian banks' structural reliance on wholesale funding markets remains a key credit sensitivity, how they manage their funding and liquidity, as credit growth picks up, will represent an important rating focus," added Moody's analyst and assistant vice-president Daniel Yu.